The Pitch: Weight Watchers Can Add Girth to Your Portfolio

Apr 30, 2013

Obesity is an epidemic in the United States and the trend has only been getting worse, more than doubling since the 1970's. In 2012, about two-thirds of Americans were considered overweight. This is not limited to the United States, either. In the past two decades, obesity rates across the world have skyrocketed by 82%. Overweight adults and children are at higher risk of developing diabetes, suffering a stroke, or getting heart disease.

Such is the backdrop behind today's Top Buy pick, Weight Watchers (WTW). Weight Watchers is one of the most known and respected brands in the sometimes shady business of weight-loss solutions. Founded in 1963 by homemaker Jean Nidetch, the company has expanded into almost 30 countries and runs meetings attended by over a million people every week. The core of Weight Watchers is using a "points" system to simplify calorie counting. Members can participate through in-person meetings or through an online-only program utilizing mobile apps and (optionally) wearable activity monitors. Additionally, Weight Watchers licenses its brand to consumer products firms like Kraft (KRFT) and General Mills (GIS) and restaurants like Applebee's (DIN). Last year, meeting fees accounted for 51% of revenues (down 5.6% from 2011), Internet revenues were 27.6% (up 26.2%), in-meeting product sales (foods, points guides, magazines, etc.) accounted for 13.9% of sales (down 10.1%) and licensing and franchise royalties were 7.4% (down 8.9%).

I like Weight Watchers in the low $40's. This is a company that traded at nearly $80 a year ago and at $60 in early January. Recent operating weakness was largely attributed to advertising issues, a major one being the pregnancy of Jessica Simpson derailing a running campaign centered on her 50-pound weight loss on the system! Also, comparisons against 2011 were very difficult. 2011 was a record year, with 25-30% growth throughout.

No one should ever expect Weight Watchers to sustain 20%+ growth rates, and I certainly don't see the stock reaching the $80 point again any time soon. However, I do believe that marketing campaigns can be fixed relatively rapidly, and the tough comparisons will roll off later this year. Management did admit on the Q4 conference call that weak guidance could prove to be too conservative. Even assuming high single-digit declines this year, followed by modest 5% growth after that (driven mainly by Internet, international, and business-to-business growth), I see a 35% margin of safety at current prices.

That is pretty good for such a stable business. Meeting fees are recurring and have a very high rate of renewal. Meetings are the core of Weight Watchers' economic moat - it is a differentiator that few competitors have tried to replicate, and probably couldn't even if they tried. Brand is another - Weight Watchers is still the most well-known and respected brand in weight loss, a powerful advantage over new entrants or the latest fad. Even during the deep recession in 2008-09, Weight Watchers only experienced a 9% revenue decline and still maintained a respectable 25.7% operating margin. Cash flows are stable and reliable, and I categorize Weight Watchers as a "conservative" pick.

That's not to say there are not risks. Weight Watchers' growth is coming solely from Internet revenues, with meeting fees slowly declining for much of the past decade. This is an issue, because as stated before, the core of Weight Watchers' competitive advantage is its meeting infrastructure. There are loads of (often free) mobile apps that users can track calories and exercise with.

Also, the company has a poor balance sheet. At $2.4 billion, debt dwarfs the $70 million on the balance sheet. Fortunately, Weight Watchers' reliable cash flows are more than enough to handle it, and interest obligations are covered more than 5 times over by operating earnings. Banks don't seem too concerned either, as the firm recently refinanced its entire debt load, extending maturities and ultimately reducing interest payments. Still, should operational weakness worsen, the firm could be in danger of violating debt covenants, which would be a major issue, albeit unlikely (particularly within our one-year holding period).

All in all, Weight Watchers looks like a good investment opportunity at present, despite a few warts. The sell early target is $57.

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